Taxing Financial Transactions

Throughout the financial regulation debate, I've always thought that there is a better way to reduce the scope for high-frequency trades in exacerbating a crash than by regulating the frequency (or volume) of trades themselves. If you want to reduce something in the least discriminatory and most transparent way possible, a tax is the way to go. A sufficiently small tax on financial transactions should limit the extent to HFTs magnify crashes while imposing the least amount of distortion in the market in general. Some better discussion here and here.
I feel similarly about campaign finance reform.

Subprime Lending and Lobbying

Funny. Lots of "government failure" advocates for explaining the housing bubble point to all sorts of things that the democrats did in the 1970s and before (in addition to the horrible, horrible greed of poor people) for somehow precipitating the sudden rise in subprime loans. Few point to this (note the bill's sponsor), and even fewer likely want to see this (full, but gated, article here).

No Competition Catch-All

Competition fixes a lot in markets; not everything, like this for example:

In the case of the credit ratings agencies competition seems to be exactly what the problem is! As long as the credit ratings agencies' customers are the companies seeking a rating, and as long as those same ratings agencies have a stake in the success of the raising of financial capital for the bond issue, there will be moral hazard in the market. Competition will not improve the problem, because as the piece notes, companies are already shopping around for the "best" deal!

Some Links, Should Travellers to AZ take their Passports?

Menzie Chinn asks if he should (here; news story on the law here; resolution summary here). If you solve the subsequent subgame, I'm sure someone'll get the idea that only stoping people with different skin colors or accents is a violation of civil rights, and that'll mean I should, too.
High-skilled immigrants make the economy go (here); maybe not for long (here).
Governments move to regulate remittances (here); what central bankers think of it (step one: keep better data here); mobile remittances might help keep better data (here).
How do temporary shocks affect modern economies? (Not much - here)
China's real estate bubble? (Economist, here; LA Times, here; Business Week, here) Some excerpts:

Taxi drivers boast of owning multiple flats for investment. (LA Times)

and

"My maid just asked for leave... She's rushing home to buy property. I
suggested she borrow 70% so she could cap the loss." (Business Week)

and

It's somewhat reassuring that buyers are plunking down sizeable downpayments. (Economist)

On #3, two comments: (1) ... for now; and (2) is it? If folks are leveraging 70% on speculation about the value of an asset that has had a historical real appreciation close to zero how much does it matter that they own a meager 30%? Again, you buy a house for the dividends of its use value. Investment value is speculation. and eventually a bubble.

Some links, with tragedy of the commons in Zimbabwe

A good picture of the tragedy of the commons - the reason Elinor Ostrom shared the economics Nobel last year.
The Harvard undergraduate thesis everyone's talking about.
Does taking the first, possibly temporary, job in a crisis hurt future EP?

Some links, featuring abortion-reducing universal coverage, and deferred benefits payments in Virginia

Free health care = fewer abortions, according to Cardinal Hume (Economix)
Virginia slashes public services, including an agreement "to defer $620 million in contributions to the state pension system over the next two years." Does that mean I should worry about my 403(b)? Or, does it mean that bankers don't have to pay their bills, the state doesn't have to pay its bills, so I don't have to pay my bills? (Roanoke.com)
Microinsurance (The Economist)
China's hidden debt (The Economist)
Blogonomics (Economist's View)
National Security argument for amicable trade with China (Free Exchange)
Germany's trade surplus - somehow not as controversial as China's (Free Exchange)
If radical free market ideas can't win in the free market of ideas, use government intervention to push them on students (Economist's View)
Hardest logic puzzle ever? (FT)

More Financial Innovation that Doesn't Suck

For the last couple of years unbanked Kenyans have been using their mobile phones as mobile banks, which has proved invaluable as a means for small savings and remittance transfers for poor households.

Using Derivatives for Good Instead of Evil

This excerpt Robert Pozen's "Too Big to Save? How to fix the US Financial System" points to a good use for derivatives (HT: Marginal Revolution):

The Danish model has another critical and innovative feature.  Holders can retire their own mortgages by purchasing the same face amount of mortgage bonds at the prevailing market price.  To prepay a mortgage by purchasing bonds, the home owner must give advance notice of several weeks to the MCI [mortgage credit institutions], which designates by lottery the specific bonds to be purchased.  Thus, if rising interest rates or other factors cause mortgage bonds to trade at a discount, home owners can reduce the principal or retire the whole mortgage by purchasing an appropriate mortgage bond at a discount.

This is an example of innovation that would make markets more robust help prevent foreclosures, rather than the types of innovations we've seen in the US, which are mostly meant to subvert regulations. The fact that this has not evolved in the US makes me think two things: One, that the balance of power IS tilted in favor of banks and against the consumer (maybe due to lobbying power, which Adam Smith and other "classical" market economists warned against); and two, that the regulatory framework has created some degree of moral hazard and/or regulatory capture (i.e. banks are taking risks and doing things way beyond what they would normally do because they do not face consequences from the market, i.e. bailouts, or the regulators, i.e. bureaucratic corruption) over the last 30 years.

Bigshots on Financial Innovation

Tyler Cowen and Felix Salmon duke it out while Mike Konczal holds middle ground.

Question about the housing bubble/financial crisis.

If the housing bubble and financial crisis can be attributed to a small incentive to give a small percentage of home loans to poor borrowers in the US, why did UK and Germany have bubbles and crashes, too, and why did UBS and RBS have their own subprime crises? I mean it seems like an obvious way to debunk the "deregulation and 'innovation' were great it was the liberals' fault for trying to help poor people."

Some Banks Do Fail

Here's a list since Feb. 2007:

	Bank Name	Closing Date
1	First Bank of Idaho, Ketchum, ID	24-Apr-09
2	First Bank of Beverly Hills, Calabasas, CA	24-Apr-09
3	Heritage Bank, Farmington Hills, MI	24-Apr-09
4	American Southern Bank, Kennesaw, GA	24-Apr-09
5	Great Basin Bank of Nevada, Elko, NV	17-Apr-09
6	American Sterling Bank, Sugar Creek, MO	17-Apr-09
7	New Frontier Bank, Greeley, CO	10-Apr-09
8	Cape Fear Bank, Wilmington, NC	10-Apr-09
9	Omni National Bank, Atlanta, GA	27-Mar-09
10	TeamBank, National Association, Paola, KS	20-Mar-09
11	Colorado National Bank, Colorado Springs, CO	20-Mar-09
12	FirstCity Bank, Stockbridge, GA	20-Mar-09
13	Freedom Bank of Georgia, Commerce, GA	6-Mar-09
14	Security Savings Bank, Henderson, NV	27-Feb-09
15	Heritage Community Bank, Glenwood, IL	27-Feb-09
16	Silver Falls Bank, Silverton, OR	20-Feb-09
17	Pinnacle Bank of Oregon, Beaverton, OR	13-Feb-09
18	Corn Belt Bank and Trust Company, Pittsfield, IL	13-Feb-09
19	Riverside Bank of the Gulf Coast, Cape Coral, FL	13-Feb-09
20	Sherman County Bank, Loup City, NE	13-Feb-09
21	County Bank, Merced, CA	6-Feb-09
22	Alliance Bank, Culver City, CA	6-Feb-09
23	FirstBank Financial Services, McDonough, GA	6-Feb-09
24	Ocala National Bank, Ocala, FL	30-Jan-09
25	Suburban Federal Savings Bank, Crofton, MD	30-Jan-09
26	MagnetBank, Salt Lake City, UT	30-Jan-09
27	1st Centennial Bank, Redlands, CA	23-Jan-09
28	Bank of Clark County, Vancouver, WA	16-Jan-09
29	National Bank of Commerce, Berkeley, IL	16-Jan-09
30	Sanderson State Bank, Sanderson, TX	12-Dec-08
31	Haven Trust Bank, Duluth, GA	12-Dec-08
32	First Georgia Community Bank, Jackson, GA	5-Dec-08
33	PFF Bank and Trust, Pomona, CA	21-Nov-08
34	Downey Savings and Loan, Newport Beach, CA	21-Nov-08
35	The Community Bank, Loganville, GA	21-Nov-08
36	Security Pacific Bank, Los Angeles, CA	7-Nov-08
37	Franklin Bank, SSB, Houston, TX	7-Nov-08
38	Freedom Bank, Bradenton, FL	31-Oct-08
39	Alpha Bank & Trust, Alpharetta, GA	24-Oct-08
40	Meridian Bank, Eldred, IL	10-Oct-08
41	Main Street Bank, Northville, MI	10-Oct-08
42	Washington Mutual Bank, Henderson, NV and Washington Mutual Bank FSB, Park City, UT	25-Sep-08
43	Ameribank, Northfork, WV	19-Sep-08
44	Silver State Bank, Henderson, NV	5-Sep-08
45	Integrity Bank, Alpharetta, GA	29-Aug-08
46	The Columbian Bank and Trust, Topeka, KS	22-Aug-08
47	First Priority Bank, Bradenton, FL	1-Aug-08
48	First Heritage Bank, NA, Newport Beach, CA	25-Jul-08
49	First National Bank of Nevada, Reno, NV	25-Jul-08
50	IndyMac Bank, Pasadena, CA	11-Jul-08
51	First Integrity Bank, NA, Staples, MN	30-May-08
52	ANB Financial, NA, Bentonville, AR	9-May-08
53	Hume Bank, Hume, MO	7-Mar-08
54	Douglass National Bank, Kansas City, MO	25-Jan-08
55	Miami Valley Bank, Lakeview, OH	4-Oct-07
56	NetBank, Alpharetta, GA	28-Sep-07
57	Metropolitan Savings Bank, Pittsburgh, PA	2-Feb-07

Madoff

Here's Madoff's indictment: 

http://clusterstock.alleyinsider.com/2008/12/bernie-madoff-the-indictment

McCains mortgage buyout plan: Bad policy, bad politics.

Delinquency Rates for Loans, all banks (source: Federal Reserve):

.........Real...Res...Comm.......Credit............................
........Estate..R.E...R.E...Cons..Card..Oth..Leases..C&I...AG...Total
2008 Q2:..4.21..4.33..4.24..3.57..4.90..2.80..1.54..1.67..1.10.. 3.31

Homeownership rate: 68.8

Bank Sector employment and earnings:

...........Employment...hr/wk...$/hr....$/wk....$/year
July 2008:..8,206,000...35.8...20.28...726.02...36,300

Labor force: 134 million

The point is, I got the feeling from Mr. McCain's plan to pay banks face value for mortgage assets and negotiate the principle down with the borrowers was a bad idea. It smacked of a second-best solution (like trade policy intervention), or at least one that would mess up a lot for very little gain.

Turns out, that seems to be the case. Employment in all financial services is about 8% of the workforce. Delinquent loans are at most about 3 percent of all households (less if you consider the fact that not all households who are homeowners have a mortgage). Who wins this way of doing it? 11 million people who didn't make wise decisions. Who loses? the 90% of us who were prudent. Moral hazard anyone?

Asymmetric Information & Mechanism Design

Some thoughts on state-contingent warrants against the changes in values of bailout assets bought by the Treasury, from E40. It plays some on my previous post on the whole issue of behavioral assumptions, and the argument for this type of mechanism design is strengthened by the tendency opportunistic behavior by bailees.

Financial Crisis & Williamson's Behavioral Taxonomy

The whole crisis in the financial sector made me reflect today on Oliver Williamson's thoughts on transactions costs economics and behavioral assumptions built into various models economists employ. The basic taxononmy can be represented by looking at agents' behavior in two dimensions, rationality (maximizing, bounded rationality, and organic rationality or rationality as an evolutionary process) and self interest motivation (opportunistic, simple self-interest, or obedient).

Mostly, the relationship in the crisis comes down to a philosophical question of rationality - how well did folks figure out what kind of trap they were getting themselves into - and greed - how willing were agents to take advantage of others to get ahead.

Realistically, if agents are acting opportunistically, the type of economic organization that leads to the best outcomes is mechanism design (regulation). Unfortunately, under those circumstances, the mechanism has to be well designed. Copouts and loopholes will basically lead to another way for agents (homeowners and banks and realtors) to game the system. Furthermore, even if we're all trying to be rational the lack of information should give us more pause. Why hasn't anyone with some authority noticed this and put the brakes on this crazy rush to do "something?"

What?

The WSJ today published an opinion piece, "The Deeper the Downturn, the Quicker the Recovery." I can scarcely think of a sillier premise to start from. Has he studied history, and the economic volitility of the US and world economies prior to WWII?

If you get past the silliness of his title and basic premise, the author (Christopher Wood) makes some interesting points about moral hazard and "debt deflation," but it would be unwise to conclude from those ideas that a steeper fall will mean a quicker recovery and a better long-term outlook. If the fall is deep then most of that "quicker recovery" will be wasted just trying to catch back up to where we were before.

Optional ARM

I've moaned about the "negative amortization option" on three part optional ARM mortgages here already. Basically an optional ARM an adjustable rate mortgage that lets you pay one of three payments (not by agreeing to it in advance but on a month to month basis):
1. normal payment that (if made each and every month) amortizes the loan after X months.
2. interest only payment that (if made each month) never amortizes the loan (the bank perpetually owns your house).
3. "negative amortization" payment that doesn't even pay off the interest, and adds the difference onto the principle (I'd rather call this the "default incentive" option - do this as long as the bank will let you, default, foreclose, and rent for the rest of your life).
Now the Economist is onto the stupidity (just so you know that I'm not making this stuff up).

Big Mac Housing Index

So, weird title... Got to THIS on Calculated Risk via Krugman's conscience. A lot of conservatives (some of whom I know well as friends and relatives), whose convictions are sometimes unencumbered by inconveniences like facts, like to blame huge million-dollar McMansions and yuppies getting in over their head for both the housing bubble and the POP. The rationale is that the high-end houses had more money chasing them, and at the same time had farther to fall, and it was a fairly logical argument.

But there are convincing theoretical rationales to suggest the exact opposite, and in fact the Data for LA and Minneapolis suggest the opposite. Lower-quintile housed seemed to have a larger proportional increase AND a larger proportional decrease during the crash. Basically, what was happening on this end was that complicated loan scheems that perpetuated the bubble, and led to the subsequent forclosures and crash, were almost exclusively offered (and accepted) by lower-income borrowers who otherwise couldn't afford to buy.

An example is the Payment-Option ARM - Borrowers got their ARM with an option EACH MONTH (not at the outset of the contract, but EACH MONTH) to pay: the normal amortization payment; the interest-only payment, or; the "negative amortization" payment, which kept adding on to the principle. Holy SH..neikkies! This didn't just give people one chance at a bad desicion, but a seemingly neverending sequence of monthly opportunities to display their inexperience with finance.

Profits and Poppies?

Economically, it's difficult to understand why opium crops are so substantial in Afghanistan. The classical explanation would be that it's the most profitable use of that land and of those farmers' time. But, there's some research, summarized by The Economist, suggests that ain't so.

Recent research suggests that greed on the part of farmers, at least in
this part of the country, is actually a fairly minor factor in the
decision to plant poppy.
David Mansfield, a researcher for the Afghan Research and Evaluation
Unit, a think-tank, has produced statistics showing that Nangarhar
poppy farmers are rarely the richest people in their communities. Their
profits from poppy are often barely higher, and sometimes lower, than
those from legal crops, particularly where they have to use petrol
generators to pump water to their crops.

So what gives? One clue is that illegal smugglers might be the only ones filling a hole in the capital market and provision of public goods (adequate transport).

Smugglers would visit farms to buy opium. They made loans against
future production ahead of the planting season. Dry opium keeps for up
to two years, so farmers can save it as capital and sell when the
market looks favourable.

Hmmm. Interesting...Basically smugglers are making contracts with farmers for future delivery (futures markets), and the storability of poppy helps make up for the risk involved with poor roads and the inability to get your crop to morket before spoiling.

Consumption Smoothing and "Irrational" Savings

I'm just going to post a link to this, dedicate it to a certain special someone I know (who happens to feel strongly and differently about personal finance) and say nothing more than, "I'm not the only one out there who thinks this way."